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Following the flows

Made in Germany, owned by China: a robotic arm made by Midea’s Kuka pours Bavarian beer

Less than a year after the Shanghai Stock Exchange launched with fits and starts in late 1991, the Chinese government began preparing to open the stock market to foreign capital.

There were only eight A-share firms listed in Shanghai at the time with a combined market value of not much more than $400 million. One of them, Shanghai Vacuum Electronic Device, was picked as the first company to sell B-shares, a new type of stock limited to overseas investors.

Shanghai Vacuum’s full name was potentially misleading – it was a maker of television vacuum tubing – and foreign investors were not given much insight into the state-owned enterprise’s financial health. Four of six original underwriters on the deal withdrew and B-shares turned out to be a botched attempt at market-opening in general. Investors who took the plunge soon found they were trapped in a hopelessly illiquid market. All the same, almost 60 B-share companies went public between 1992 and 1994, most of them backed by local governments. But overseas interest in the listings dried up once Beijing began to allow its more powerful SOEs to go public on overseas bourses such as Hong Kong and New York.

Chinese stocks’ “Long March to credibility”, as Caixin Weekly termed it, passed another milestone this month with the addition of some 234 A-shares to the widely followed MSCI Emerging Markets Index.

That said, only 60 or so have found their way into the portfolios of global fund houses so far, which raises the question about whether foreign investors have enough information on the Chinese firms on offer this time around.

Here’s a quick review of some of the most popular of the newly included stocks – some of which WiC has tracked for almost 10 years.

Having breached Rmb800 this week, the distiller of the most storied rice wine, or baijiu, is the most expensive in per-share terms among all the Chinese stocks, thus earning its nickname among local investors as the “King of A-shares”.

Previously newspapers had described Moutai as “the world’s largest luxury goods company by market value”, benchmarking the Guizhou-based firm with LVMH. The owner of Louis Vuitton has since reclaimed the top position after an 11% correction in Moutai’s share price in the first half of this year. The French firm was worth about $180 billion this week versus Moutai’s $150 billion.

Yet Moutai is still the most valuable liquor maker in the world. More importantly, it is also one of the most iconic brands in China. It was the “national wine” of choice when Chinese Premier Zhou Enlai toasted visiting American President Richard Nixon in 1972. And it was on the dining table again when Xi Jinping hosted his North Korean counterpart Kim Jong-un in Beijing last month.

This intangible brand value, Hong Kong Economic Times has noted, is one of the reasons why Moutai has been one of the most sought-after A-shares for foreign investors.

Yet while China’s overseas-listed energy and banking majors have been part of the MSCI universe for some time, Moutai is one of the few heavyweights that has not. This partly explains why its share price has nearly doubled since MSCI announced its decision to include A-shares in its key index a year ago, with global investors taking positions in Moutai well ahead of the inclusion of Chinese stocks in the MSCI index this month.

The ubiquity of bottles of Moutai at official banquets, or as gifts to public officials, meant that its shares were once regarded as a proxy for measuring the spread of corruption (see WiC172). President Xi’s anti-graft campaign – launched in late 2012 – then triggered a halving in the share price in less than two years. But the company has repositioned its products to meet more of the demand of China’s growing middle class (see WiC325) and the stock has bounced back.

This blue-chip consumer play has been given the biggest single weighting of any of the 234 counters added by MSCI this month. Policy risks remain a concern, though. Since January domestic critics have taken the company to task for failing to share more of its profits with Chinese sorghum growers.

Perhaps that’s why Moutai has been talking up its social responsibility programmes and it has even built a hospital and university in the eponymous city where it is based in Guizhou province (see WiC378).

And the biggest ‘Big Brother’

One of the challenges for foreign fund managers in picking A-shares is understanding the true ownership structures of Chinese firms, especially when the line between SOE and private-sector firm is often blurry.

While Moutai is more than 60% controlled by the Guizhou government, the situation is less clear-cut for another of the top three stocks bought by overseas investors ahead of MSCI inclusion: Hikvision Digital Technology, a global leader in surveillance systems.

The Shenzhen-listed firm was founded in 2001 and influenced from the outset by the now modish concept of ‘mixed ownership’, in which state ownership and private capital are supposed to combine.

China Electronic Technology Group Corp (CETC) – which played a key role in developing the country’s nuclear missile capability – is Hikvision’s biggest shareholder with a 39% stake (see WiC375), while company founder Gong Hongjia (dubbed as one of the country’s best angel investors, see WiC180) has been selling down his stake in the Hangzhou-based firm in recent years.

Foreign investors have made efforts to better understand what Hikvision is and what it is not. According to Securities Daily, the company has been interviewed by analysts and fund managers nearly 360 times in the past two months.

Some of those investors might welcome Hikvision’s close association with the Chinese government. After all, the authorities have been building one of the world’s biggest AI-powered surveillance networks and Hikvision is the major supplier of the cameras.

Big Brother equals big gains, it seems. Following a 40% rise in its share price over the past year, Hikvision now carries a market value of Rmb370 billion and is the most valuable stock among companies listed in Shenzhen, the second of China’s main bourses.

While Hikvision’s domestic business looks to have excellent growth prospects, the ZTE experience offers a cautionary tale about the potential risks to its international ambitions. What happens, for instance, if Donald Trump’s administration turns testy on Hikvision, whose surveillance cams are already installed across the US? Hikvision only makes about 15% of its revenues overseas but another concern – as with ZTE – is that its products require foreign parts to function. So it too might be vulnerable to a US ban on tech exports.

Finding the ‘white horses’…

The key index in China, the Shanghai Composite, is compiled in a manner that means that every listed firm is a constituent. Hence the concept of ‘blue-chips’ does not really apply for A-shares. Instead, local stock commentators use the term ‘white horse’ to describe the companies with the greatest potential.

The white goods sector is one of the leading stables for these white horses. Take Gree Electric, the Zhuhai-based manufacturer of China’s leading air-conditioner brand. Investors who bought into Gree 10 years ago are sitting on a 1,000% return. Even those who invested three years ago would have tripled their money.

However, it is Midea, another electric appliance maker based in Guangdong, that has the biggest weighting in the MSCI of the white goods makers (about 2% of the A-share allocation versus 0.8% for Gree).

That is probably because Midea has a much higher market value if you adjust for the free float. While the Zhuhai branch of Sasac, the agency that manages SOE assets, remains the biggest shareholder of Gree, Midea, which started out as a state-owned factory, was effectively privatised by its tycoon owner He Xiangjian via a reverse takeover in 2013 (see WiC210).

As such, Forbes describes He as China’s seventh richest man with a net worth of more than $20 billion. Gree’s chairwoman Dong Mingzhu is cast more as a professional manager who often finds her decisionmaking questioned by the Zhuhai Sasac bosses (see WiC345).

Midea’s market capitalisation has climbed nearly five times in as many years to Rmb362 billion. Light industrial manufacturers such as Gree and Midea have also been pioneers in the so-called ‘Made in China 2025’ initiative, devised by the government to encourage local firms to embrace innovation. With the backing of Beijing, China’s largest appliance makers have been the trailblazers in overseas M&A activities (see WiC339), and Midea’s $5 billion acquisition of German robotic firm Kuka (see WiC326) stands out as a leading example of corporate China buying its way into the technological future.

The IPO market is warming up too

Given the stellar performance of Midea (which according to the Financial Times has now replaced Panasonic as the largest white goods maker by revenues), it is hardly surprising that one of the hottest primary market offerings this month came from the same sector: advanced electronics.

Ecovacs Robotics, the country’s leading maker of floor-cleaning robots, climbed by the trading debut limit of 44% on Monday after raising about Rmb800 million in an initial public offering.

Founded in 1998, Ecovacs initially focused on making vacuum cleaners and parts for foreign brands but it has since grown into a well-known brand of its own, with a Rmb22 billion market value.

Another company which looks likely to make the cut in the next wave of MSCI inclusions is Foxconn Industrial Internet (FII). A spin-off from Taiwanese contract manufacturer Hon Hai, it made its trading debut in Shanghai today and its shares were up the maximum 44% in the morning session. FII raised Rmb27 billion in the biggest A-share IPO since 2015. Its market value now stands at Rmb390 billion, which makes it the biggest tech-related A-share.

It will use the funds to position itself as a solutions provider in smart manufacturing. That includes areas like robotics and the Internet of Things (for instance sensors) which research firm IDC estimates Chinese manufacturers will spend $128 billion on by 2020.

Other major A-share offerings are in the pipeline too. On Wednesday, the Chinese Securities Regulatory Commission (CSRC) announced it had approved the IPO application of PICC. The insurance giant is already listed in Hong Kong and now plans to issue up to 4.6 billion shares in Shanghai in an offering that could raise at least Rmb10 billion.

In China a robust primary market is often the best catalyst for a bull market, because the country’s retail investors (and many of its institutions as well) are obsessed with speculating in new shares.

However, regulators are cautious about flooding the market with too many mega IPOs in a short space of time, Securities Daily notes, because it could dampen sentiment in the secondary market as cash is diverted to the new offerings.

There were more than 300 candidates waiting for approval to IPO at the end of May, and the median wait for getting the green light to proceed is 536 days, according to data from Bloomberg. All eyes are now on whether the regulator will shorten the wait time.

A dose of Chinese medicine?

A major chunk of the Chinese economy has long been represented in MSCI’s global indices through shares trading on other bourses, such as Hong Kong-listed Tencent, or SOE giants like oil major PetroChina.

In 2015, a year after the indexing firm started to review whether to include A-shares, it added 14 Chinese firms with listings in the US to its indices. Most of them were internet stocks such as Alibaba, Baidu, NetEase and Qihoo.

A question that’s now on the minds of many fund managers is whether these firms would be wise to return to the A-share market.

In valuation terms, the answer may be yes. Qihoo, for instance, disappeared from New York in 2016 in a buyout deal worth $9.3 billion. When it reappeared as an A-share in Shanghai in March, its market value had surged to Rmb231 billion, or $37 billion.

Another notable case is Wuxi AppTec. China’s biggest contract medical researcher was worth $3.3 billion shortly before it delisted from the New York bourse in 2015. Since making its trading debut in Shanghai in early May, its share price has surged by almost six times, and its market value now exceeds $20 billion.

Investor appetite has reached such a frantic state that Wuxi AppTec had to issue a warning last month that its valuation looked aggressive compared with industry peers.

Another pharma stock to watch is Yunnan Baiyao. It is the second largest of the A-share listed biotech and healthcare firms and is another star performer that made the MSCI list of 234 stocks. Its products range from Chinese medicine pills to herbal toothpastes (where it has been taking market share in China from US multinational Proctor and Gamble, see WiC169) and over the past decade its market value has increased by a factor of 10 to Rmb113 billion.

Another consequence of the new inclusions in the MSCI benchmark is that overseas-listed Chinese giants such as the BAT trio have had their weightings in the overall MSCI China index reduced because of the inclusion of their A-share counterparts. Perhaps that’s why Baidu, Alibaba and even Tencent may now be tempted to follow suit and return home, possibly by issuing Chinese Depository Receipts (see WiC400).

More broadly, many see the inclusion of Chinese stocks as a game changer for global fund flows. Certainly, it could turn out to be the starting point for a much larger transition (the entire A-share market comprises 3,500 stocks and is currently worth about $8.5 trillion).

“China’s stock market can now become part of the global investment mainstream. International investors can no longer ignore A-shares and we expect over $600 billion of inflows into Chinese equities over the next five to 10 years because of MSCI inclusion,” is the verdict of Helen Wong, HSBC’s chief executive for Greater China.

In fact MSCI predicts that the newly included large-cap A-shares plus China-listed shares in Hong Kong could make up more than 40% of the MSCI Emerging Markets Index. Should midcap A-shares eventually be included, Chinese companies would represent nearly one out of every two companies in that index.

That will make China’s equity markets increasingly hard for international investors to ignore.

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